- Income can be protected from taxes through depreciation and expense right-offs
- Taxes on appreciated gains can be deferred and potentially avoided altogether though a 1031 Exchange
- Overall returns can be turbocharged using leverage (debt)
- Day to day volatility is lower and not as subject to market corrections
- Real estate is a tangible asset with inherent scarcity and uniqueness
Even in dark periods such as the global financial crisis in 2008 where virtually all asset values plummeted, income from real estate investments remained positive due to tenant occupancy which remained favorable.
The NCREIF Index which measures the performance of US commercial real estate properties reported an annual return of 12.7% in 2015 which outpaced other key indexes such as the S & P 500, Dow 30, and the Russell 2000. Over the past 15 years, including the 2008 meltdown, the NCREIF Index reported an average annual return of 8.8% which is 200 basis points higher than the S & P 500 during the same period.
One of the first principles learned by all investors is the inherent trade-off between return and risk i.e., the greater the return, the greater the risk – and vice versa. With experience, however, many investors learn and apply techniques which can increase their returns without necessarily raising their risk of loss. One of the most common ways of achieving higher returns without added risk is to take advantage of existing tax laws that favor the treatment of certain types of investments over others, thereby allowing investors to keep a higher percentage of their gains.
While the US tax code contains thousands of such preferential tax advantages covering many types of investments ranging from making movies to investing in municipal debt, one of the largest remaining areas of favorable tax treatment is real estate.
The range and degree of tax advantages has declined from the high tax years of the 1980’s when real estate investments were often done even if the investment did not make a return since allowed write-offs could be taken for several times the amount of the original investment. While tax reforms have since eliminated these extreme advantages, today’s real estate investors are still allowed to significantly improve their net income utilizing depreciation of physical assets such as buildings, and deducting mortgage interest and expenses. Investors can also defer and even eliminate capital gains on the sale of their real estate assets by taking advantage of Section 1031 of the Internal Revenue Code which dates to 1921.